Dish Network (NASDAQ:DISH), has been battling television recording device manufacturer TiVo (NASDAQ:TIVO) over patent infringement issues for several years now. The fate of Dish Network’s DVR business may turn on the outcome of the legal battle.
Dish Network is the second-largest satellite pay-TV service provider in the U.S., trailing DirecTV (NASDAQ:DTV). The lawsuit dates back to 2004, when TiVo sued Dish for allegedly infringing on TiVo’s patents for time-shifting video technology in DVRs that Dish leases to its customers. To date, courts have ordered Dish Network to pay TiVo more than $400 million in damages, according to the Associated Press. Dish has appealed these rulings.
TiVo won a key ruling against Dish in early 2010. Dish then asked the entire bench of the federal circuit court to review the decision. The court has now scheduled a hearing for November 2010, suggesting that the patent saga might be nearing an end.
If Dish Network loses the TiVo case it could be forced to shut down its DVR business, or else replace all its existing DVRs with alternative technology. Alternatively, it might wind up paying licensing fees to TiVo. We analyze these three scenarios below and trace their possible impact on Dish’s stock.
Scenario #1: Dish pays license fees
If TiVo wins the patent infringement case, Dish may strike a licensing deal with TiVo to avoid replacing millions of DVRs across its subscriber base. Dish Network would then pay TiVo a monthly fee for each DVR that Dish’s customers use. This fee could range anywhere from $1.75 to $4 per DVR per month, according to several analyst estimates cited by USA Today.
Let’s assume that Dish winds up paying TiVo a $2.25 license fee per DVR starting in 2011. In this scenario, Dish’s gross margins on DVR leases would be squeezed by 12.5% to 14.5%, resulting in a downside of about 11.5% to our current stock price estimate.
You can drag the trend-line in the chart above to create your own DVR gross margin estimate for Dish Network and see how it impacts the company’s stock price.
Scenario #2: Dish buys all new DVRs
If Dish loses in court, it might opt to replace its current stock of DVRs with new machines from an outside vendor. Dish currently has more than seven million DVR subscribers. Each subscriber leases two DVRs on average, which means that Dish would need to replace more than 14 million DVRs. This would cost nearly $3.5 billion, assuming an average DVR cost of $250.
If Dish was to replace all 14 million DVRs next year, its capital expenditures would skyrocket, causing a potential 15% downside to our price estimate. In the chart above you can drag the trend-line to create your own capital spending forecast for Dish and see how it impacts the company’s estimated share value.
Scenario #3: Dish exits the DVR business
Last May, Dish Network’s management said they might get out of the DVR business altogether if TiVo prevails in the lawsuit. In this scenario we estimate that Dish Network would lose close to 16.5% of its value.
Dish had a subscriber base of nearly 14 million at the end of 2009. As mentioned above, it had close to seven million DVR subscribers, each of whom leased two DVRs on average. These subscribers pay a monthly fee of about $6 per DVR and add close to $1.5 billion in value to Dish Network, including the impact of net debt.
Dish could lose additional value as dissatisfied subscribers migrate to other service providers who provide DVR service. Overall, we would expect a 16.5% downside to our stock price estimate if If Dish exits the DVR business and maintains current debt levels.